UPDATE 2-UK financial regulator slams HBOS, waives fine

* FSA says found "very serious misconduct" at HBOS

* Enforcement proceedings linked to HBOS continue

* Report on HBOS failure to come once proceedings completed

By Myles Neligan and Huw Jones

LONDON, March 9 HBOS, now part of Lloyds
Banking Group, was censured by Britain's financial
watchdog on Friday for failing to control risky lending in the
run-up to the financial crisis, escaping a hefty fine to avoid
taxpayers being hit twice.

HBOS failed to rein in high-risk loans at its Bank of
Scotland unit from April 2008 even as competitors pulled back
because of worsening financial conditions, the Financial
Services Authority said.

The "very serious misconduct" was also in spite of warnings
from the bank's own risk officials and external auditor KPMG,
the FSA said.

The watchdog said it had waived the "very substantial" fine
HBOS would normally incur as any penalty would be borne by the
taxpayer, owner of a 41 percent stake in Lloyds after both it
and HBOS were bailed out at the height of the crisis.

"The conduct of the Bank of Scotland illustrates how a
failure to meet regulatory requirements can end not just in
massive costs to a firm, but losses to shareholders, taxpayers
and the economy," the FSA's acting director of enforcement
Tracey McDermott said.

The regulator said in a 37-page enforcement notice that it
had concluded its enforcement action against the company, but
other proceedings linked to the failure of HBOS continue.

The FSA declined to comment.

Once all enforcement actions have been completed, the FSA
said it will begin work on a report on the failure of HBOS, as
it did with Royal Bank of Scotland, now 80 percent-owned
by the state after receiving an emergency cash injection.

Lloyds said it welcomed the FSA's findings.

"This will help to draw a line under the events in question
and allow the group to move forward," the bank said in a
statement.

Andrew Tyrie, chairman of Britain's parliamentary treasury
committee, said, "From what we can tell, corporate governance
was a shambles and needs thorough investigation."

"Given the deterrent role of a fine it would also have been
helpful if the FSA could have given us an idea of the scale of
the fine it would have imposed," Tyrie said.

HIGH-RISK

The FSA's investigation centred on the corporate lending
division of HBOS's Bank of Scotland unit, run by Peter Cummings.

The regulator said that for three years ending in December
2008 -- three months after the collapse of U.S. bank Lehman
Brothers sent global financial markets into near-meltdown --
HBOS failed to control risks properly as required under FSA
rules.

The watchdog said HBOS's corporate unit pursued an
aggressive growth strategy with a specific focus on "high-risk,
sub-investment grade lending" in the property market.

Markets worsened in 2007, when defaults against U.S. home
loans triggered the sub-prime crisis that paralysed interbank
lending, triggering a wave of banking failures starting with the
collapse of Britain's Northern Rock in September that year.

This did not stop HBOS where the culture of the corporate
unit was "strongly focused on revenue rather than on risk
adjusted returns."

"Between April and December 2008, the firm failed to take
reasonable care to ensure that Corporate adequately and
prudently managed high value transactions which showed signs of
stress," the FSA said.

The wider group's risk controls failed to rein in the
corporate unit where the full extent of stress was "not visible"
to the company's board or external auditor KPMG, the FSA said.

The corporate unit did not re-evaluate the growing risks --
which would have forced it to hold bigger capital buffers -- but
instead "sought to increase market share as other lenders
started to pull out of the markets" in which it operated.

This meant that calculations for the corporate unit's safety
buffers "were consistently made at the optimistic rather than
the prudent end of the range, despite warnings from the
divisional risk function and the firm's auditors".

HBOS, at the time Britain's biggest mortgage lender, agreed
to be taken over by Lloyds in a government-engineered deal in
September 2008.

In February the following year, Lloyd's had to more than
double the level of impairments on its assets to 7 billion
pounds from 3.3 billion to take account of bad loans at HBOS.

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